Transcript Financial Management - Welcome to Indian Institute of

CAIIB
• CAIIB- FINANCIAL MANAGEMENT
• - MODULE –D – WORKING CAPITAL &
TERM LENDING
• -Prof. R.S. Ullal
• Consultant & Faculty
Module D topics
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Marginal Costing
Capital Budgeting
Cash Budget
Working Capital
COSTING
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Cost accounting system provides information
about cost
Aim : best use of resources and maximization
of returns
cost = amount of expenditure incurred( actual+
notional)
Purposes +profit from each job/product,
division,
segment+pricingdecision+control+profit
planning +inter firm comparison
Marginal costing
• Marginal costing distinguishes between
fixed cost and variable cost
• Marginal cost is nothing but cost of
Producing an additional unit
• Marginal cost= variable cost, if such cost
does not require creation of additional
facilities.
• MC= Direct Material + Direct Labour
+Direct expenses
Marginal costing problems
• Sales - variable cost = contribution
• Contribution/ (divided by) sales
= C.S. Ratio
• Contribution=Fixed cost (at Break
even point)
• Fixed Cost / (divided by) contribution
per unit = break even units
Basic formula
Sales price (-) variable cost= contribution
SP less
VC
=
Contribution
10
6
=
4
9
6
=
3
8
6
=
2
7
6
=
1
6
6
=
0
5
6
=
(1)
4
6
=
(2)
Marginal costing problems
• SP = Rs.10, VC =Rs.6 Fixed Cost
Rs.60000
Find
- Break even point (in Rs. & in units)
- C/S ratio
- Sales to get profit of Rs.20000
Marginal costing problems
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Sales Rs.100000
Fixed Cost Rs.20000
B.E.Point Rs.80000
What is the profit ?
Management decisions- assessing
profitability
CONTRIBUTION/SALES=C.S.RATIO
Product sp
vc
Contribtion
c/s
A
20
10
10
10/20 50%
1
B
30
20
10
10/30 33%
2
C
40
30
10
10/40 25%
3
Ratio %
ranking
DECISION when limiting factors
SP
Rs.14
Rs.11
VC
8
7
Contribution
Per unit
Labour hr. pu
6
4
2
1
Contri.per hr
3
4
DECISIONS
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Make or buy decisions
Close department
Accept or reject order
Conversion cost pricing
Marginal costing
• cost-volume-profit analysis is reliant upon a
classification of costs in which fixed and variable
costs are separated from one another. Fixed
costs are those which are generally time related
and are not influenced by the level of activity.
• Variable cost on the other hand are directly
related to the level of activity; if activity
increases, variable costs will increase and
vice-versa if activity decreases.
Marginal costing
• USES OF COST-VOLUME-PROFIT ANALYSIS
• The ability to analyse and use cost-volume-profit
relationship is an important management tool. The
knowledge of patterns of cost behaviour offers insights
valuable in planning and controlling short and long-run
operations. The example of increasing capacity is a good
illustrations of the power of the technique in planning.
• The implications of changes in the level of activity can be
measured by flexing a budget using knowledge of cost
behaviour, thereby permitting comparison to be made of
actual and budgeted performance for any level of
activity.
Marginal costing
• LIMITATIONS OF COST-VOLUME-PROFIT ANALYSIS
• A major limitation of conventional CVP analysis that we
have already identified is the assumption and use of
linear relationships. Yet another limitation relates to the
difficulty of dividing fixed costs among many products
and/or services. Whilst variable costs can usually be
identified with production services, most fixed cost
usually can only be divided by allocation and
apportionment methods reliant upon a good deal of
judgement. However, perhaps the major limitation of the
technique relates to the initial separation of fixed and
variable costs.
Marginal costing
• ADVANTAGES AND DISADVANTAGES OF
MARGINAL COSTING
• ADVANTAGES
• 1. More efficient pricing decisions can be made, since
their impact on the contribution margin can be
measured.
• 2. Marginal costing can be adapted to all costing
system.
• 3. Profit varies in accordance with sales, and is not
distorted by changes in stock level.
• 4. It eliminates the confusion and misunderstanding
that may occur by the presence of
over-or-under-absorbed overhead costs in the profit and
loss account.
Marginal costing
• 5. The reports based on direct costing are far more
effective for management control than those based on
absorption costing. First of all, the reports are more
directly related to the profit objective or budget for the
period. Deviations from standards are more readily
apparent and can be corrected more quickly. The
variable cost of sales changes in direct proportion with
volume. The distorting effect of production on profit is
avoided, especially in month following high production
when substantial amount of fixed costs are carried in
inventory over to next month. A substantial increase in
sales in the month after high production under
absorption costing will have a significant negative impact
on the net operating profit as inventories are liquidated.
Marginal costing
• 6. Marginal costing can help to pinpoint
responsibility according to organisational lines:
individual performance can be evaluated on
reliable and appropriate data based on current
period activity. Operating reports can be
prepared for all segments of the company, with
costs separated into fixed and variable and the
nature of any variance clearly shown. The
responsibility for costs and variances can then
be more readily attributed to specific individuals
and functions, from top management to down
management
Marginal costing
• DISADVANTAGES OF MARGINAL COSTING
• 1. Difficulty may be experienced in trying to segregate
the fixed and variable elements of overhead costs for the
purpose of marginal costing.
• 2. The misuse of marginal costing approaches to
pricing decisions may result in setting selling prices that
do not allow the full recovery of overhead costs.
• 3. Since production cannot be achieved without
incurring fixed costs, such costs are related to
production, and total absorprtion costing attempts to
make an allowance for this relationship. This avoids the
danger inherent in marginal costing of creating the
illusion that fixed costs have nothing to do with
production.
CAPITAL BUDGETING
• It involves current outlay of funds in the
expectation of a stream of benefits
extending far into the future
Year
0
1
2
3
4
Cash flow
(100000)
30000
40000
50000
50000
CAPITAL BUDGETING
• A capital budgeting decision is one that involves the
allocation of funds to projects that will have a life of
atleast one year and usually much longer.
• Examples would include the development of a major new
product, a plant site location, or an equipment
replacement decision.
• Capital budgeting decision must be approached with
great care because of the following reasons:
1. Long time period: consequences of capital expenditure
extends into the future and will have to be endured for a
longer period whether the decision is good or bad.
CAPITAL BUDGETING
2. Substantial expenditure: it involves large sums
of money and necessitates a careful planning
and evaluation.
3. Irreversibility: the decisions are quite often
irreversible, because there is little or no second
hand market for may types of capital goods.
4. Over and under capacity: an erroneous
forecast of asset requirements can result in
serious consequences. First the equipment
must be modern and secondly it has to be of
adequate capacity
CAPITAL BUDGETING
• Difficulties
• There are three basic reasons why capital expenditure
decisions pose difficulties for the decision maker. These
are:
1. Uncertainty: the future business success is today’s
investment decision. The future in the real world is never
known with certainty.
2. Difficult to measure in quantitative terms: Even if benefits
are certain, some might be difficult to measure in
quantitative terms.
3. Time Element: the problem of phasing properly the
availability of capital assets in order to have them come
“on stream” at the correct time.
CAPITAL BUDGETING
• Methods of classifying investments
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Independent
Dependent
Mutually exclusive
Economically independent and statistically
dependent
• Investment may fall into two basic categories,
profit-maintaining and profit-adding when viewed
from the perspective of a business, or service
maintaining and service-adding when viewed
from the perspective of a government or agency.
CAPITAL BUDGETING
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Expansion and new product investment
1. Expansion of current production to meet
increased demand
2. Expansion of production into fields closely
related to current operation – horizontal
integration and vertical integration.
3. Expansion of production into new fields not
associated with the current operations.
4. Research and development of new products.
CAPITAL BUDGETING
• Reasons for using cash flows
• Economic value of a proposed investment can be
ascertained by use of cash flows.
• Use of cash flows avoids accounting ambiguities
• Cash flows approach takes into account the time value
of money
• For any investment project generating either expanded
revenues or cost savings for the firm, the appropriate
cash flows used in evaluating the project must be
incremental cash flow.
• The computation of incremental cash flow should follow
the “with and without” principle rather than the “before
and after” principle
Types of capital investments
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New unit
Expansion
Diversification
Replacement
Research & Development
Significance of capital budgeting
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Huge outlay
Long term effects
Irreversibility
Problems in measuring future cash flows
Facets of project analysis
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Market analysis
Technical analysis
Financial analysis
Economic analysis
Managerial analysis
Ecological analysis
Financial analysis
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Cost of project
Means of finance
Cost of capital
Projected profitability
Cash flows of the projects
Project appraisal
Decision process
INVESTMENT OPPORTUNITIES
PROPOSALS
Improvement in planning & Evaluation procedure
NEW INVESTMENT OPPORTUNITIES
PLANNING PHASE
PROPOSALS
EVALUATION PHASE
PROJECTS
SELECTION PHASE
ACCEPTED PROJECTS
IMPLEMENTATION PHASE
ONLINE PROJECTS
CONTROL PHASE
PROJECT TERMINATION
AUDITING PHASE
Methods of capital investment
appraisal
DISCOUNTING
NON-DISCOUNTING
Net present value (NPV) Pay back period
Internal rate of return
(IRR)
Profitability Index or
Benefit cost ratio
Accounting rate of return
Present value of cash flow
stream- (cash outlay
Rs.15000)@ 12%
Year
1
2
3
4
5
6
7
8
Cash flow
1000
2000
2000
3000
3000
4000
4000
5000
PV factor @12%
0.893
0.799
0.712
0.636
0.567
0.507
0.452
0.404
PV
893
1594
1424
1908
1701
2028
1808
2020
13376
Present value of cash flow
stream- (cash outlay Rs.15000
)@10%
Year
1
2
3
4
5
6
7
8
Cash flow
2000
2000
2000
3000
3000
4000
4000
5000
PV factor @10%
0.909
0.826
0.751
0.683
0.621
0.564
0.513
0.466
PV
1818
1652
1502
2049
1863
2256
2052
2330
15522
CAPITAL BUDGETING
• The advantages of IRR over NPV are:
• 1. It gives a percentage return which is easy to
understanding at all levels of management.
• 2. The discount rate/required rate of return
does not have to be known to calculate IRR. It
does have to be decided upon at sometime
because IRR must be compared with something.
The discussion as to what is an acceptable rate
of return can however be left until much later
stage. In a NPV calculation the discount rate
must be specified prior to any calculation being
performed.
• The advantages of NPV over IRR are:
• 1. NPV gives an absolute measure of profitability and hence
immediately shows the increase in shareholder’s wealth due to an
investment decision.
• 2. NPV gives a clear answer in an accept/reject decision. IRR
gives multiple answers.
• 3. NPV always gives the correct ranking for mutually exclusive
project while IRR may not.
• 4. NPVs of projects are additive while IRRs are not.
• 5. Any changes in discount rates over the life of a project can
more easily be incorporated into the NPV calculation.
• The NPV approach provides as absolute measure that fully
represents in value of the company if a particular project is
undertaken. The IRR by contrast, provides a percentage figure from
which the size of the benefits in terms of wealth creation cannot
always be grasped.
The timing of the cash flows is critical for
determining the Project's value.
below the line for cash investments or
above the line for returns.
Rs.102 lakh
Year 0
Rs.51 Lakh
Rs.51 Lakh
Rs.61 Lakh
Year 1
Year 2
Year 3
Net Present Value
Year Cash Flow Dis. Factor Present
@10%
Value
0
1
2
3
NPV
-102
51
51
61
1
0.91
0.83
0.75
-102
46.36
42.15
45.83
32.34
@27%
0
1
2
3
NPV
-102
51
51
61
1
0.78740
0.62000
0.48818
Value
-102
40
32
30
0
The evaluation of any project
depends on the magnitude of the
cash flows, the timing and the
discount rate.
The discount rate is highly
subjective. The higher the rate , the
less a rupee in the future would be
worth today.
The risk of the project should
determine the discount rate.
Internal Rate of Return
(IRR)
IRR is the rate at which
the discounted cash flows
in the future equal the
value of the investment
today. To find the IRR one
must try different rates
until the NPV equals zero.
Future value
• Assume that an investor has $1000 and
wishes to know its worth after four years if
it grows at 10 percent per year. At the end
of the first year, he will have $1000 X 1.10
or 1,100. By the end of the year two, the
$1,100 will have grown to $1,210 ($1,100
X 1.10). The four-year pattern is indicated
below.
BUDGET
• Quantitative
expression
management objective
• Budgets and standards
• Budgetary control
• Cash budget
of
PROFIT PLANNING
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Budget & budgetary control
Marginal costing
CVP and break even point
Comparative cost analysis
ROCE
PRICING DECISIONS
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pricing
Full cost pricing
Conversion cost pricing
Marginal cost pricing
Market based
PRICING DECISIONS
• PRICING AND ITS OBJECTIVES
• The objective of pricing in practice will probably be
one of the following:
• (a) To ‘skim’ the market (in the case of new
products) by the use of high prices;
• (b) To penetrate deeply into the market (again with
new products) at an early stage, before competition
produces similar goods;
• (c) To earn a particular rate of return on the funds
invested via the generating of revenue; and
• (d) To make a profit on the product range as a
whole, which may involve using certain items in the
range as loss leaders, and so forth.
PRICING DECISIONS
• Full cost pricing
• The object is to recover all costs incurred
plus a percentage of profit. It is a method
best used where the product is clearly
differentiated and not in immediate, direct
competition. It would not lend itself to
situation where price tended to be
determined by the market,
PRICING DECISIONS
• Conversion cost pricing
• Conversion cost consists of direct labour
cost and factory overhead, ignoring the
cost of the raw material on the grounds
that profit should be made within the
factory and not upon materials bought
from suppliers.
PRICING DECISIONS
• Marginal cost pricing
• Briefly it is that cost which would not be incurred if the
production of the product were discontinued. An
important advantage of differential cost of pricing is the
flexibility it gives to meet special short-term
circumstances, while accepting that full costs must be
recovered in the long term. This is by no means always
desirable in the short term. For example, there may be
surplus productive capacity in a factory, in which case
any opportunity to accept an order which covers
differential cost and makes a contribution to fixed cost
and profit should be accepted. Any contribution is better
than none.
PRICING DECISIONS
• Market based pricing
• This can be based on the value to a customer of
goods or services and involves variable pricing.
It also takes account of the price he is able and
willing to pay for the goods or services.
Businesses using this approach develop special
products or services which command premium
prices.
• The other market-based approach is to price on
the basis of what competitors are charging.
Operating leverage
Financial leverage
• OL= amount of fixed cost in a cost
structure. Relationship between sales and
op. profit
• FL= effect of financing decisions on return
to owners. Relationship between operating
profit and earning available to equity
holders (owners)
Working capital
• Current assets less current liabilities = net
working capital or net current assets
• Permanent working capital vs. variable
working capital
Working capital cycle
• cash> Raw material > Work in progress >
finished goods > Sales > Debtors > Cash>
• Operating cycle – it is a length of time
between outlay on RM /wages /others
AND inflow of cash from the sale of the
goods
Matching approach to asset financing
Total Assets
Short-term
Debt
$
Fluctuating Current Assets
Permanent Current Assets
Fixed Assets
Time
Long-term
Debt +
Equity
Capital
Accounts Payable
Raw
Materials
Cash
Value Addition
WIP
THE WORKING CAPITAL
CYCLE
(OPERATING CYCLE)
Accounts
Receivable
SALES
Finished
Goods
• Operating cycle concept
• A company’s operating cycle typically consists of
three primary activities:
– Purchasing resources,
– Producing the product and
– Distributing (selling) the product.
These activities create funds flows that are both
Working
capital cycle
unsynchronized and
uncertain.
Unsynchronized because cash disbursements (for
example, payments for resource purchases) usually take
place before cash receipts (for example collection of
receivables).
They are uncertain because future sales and costs, which
generate the respective receipts and disbursements,
cannot be forecasted with complete accuracy.
Working capital
• FACTORS DETERMINING WORKING CAPITAL
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
Nature of the Industry
Demand of Industry
Cash requirements
Nature of the Business
Manufacturing time
Volume of Sales
Terms of Purchase and Sales
Inventory Turnover
Business Turnover
Business Cycle
Current Assets requirements
Production Cycle
Working capital
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Working Capital Determinants (Contd…)
13.
14.
15.
16.
17.
18.
19.
20.
21.
Credit control
Inflation or Price level changes
Profit planning and control
Repayment ability
Cash reserves
Operation efficiency
Change in Technology
Firm’s finance and dividend policy
Attitude towards Risk
TYPES OF WORKING CAPITAL
WORKING CAPITAL
BASIS OF
CONCEPT
Gross
Working
Capital
BASIS OF
TIME
Permanent
/ Fixed
WC
Net
Working
Capital
Temporary
/ Variable
WC
Seasonal
WC
Regular
WC
Reserve
WC
Special
WC
Working capital
• Working Capital Levels in Different Industries
• A retailing company usually has high levels of
finished goods stock and very low levels of debtors.
Most of the retailer’s sales will be for cash, and an
independent credit card company or a financial
subsidiary of the retail business (which on
occasions is not consolidated in the group
accounts). The retailing company, however, usually
has high levels of creditors. It pays its suppliers after
an agreed period of credit. The levels of working
capital required are therefore low:
Working capital
• Excess of current assets over current liabilities are called
the net working capital or net current assets.
• Working capital is really what a part of long term finance
is locked in and used for supporting current activities.
• The balance sheet definition of working capital is
meaningful only as an indication of the firm’s current
solvency in repaying its creditors.
• When firms speak of shortage of working capital they in
fact possibly imply scarcity of cash resources.
• In fund flow analysis an increase in working capital, as
conventionally defined, represents employment or
application of funds.
Working capital
• In contrast, a manufacturing company will
require relatively high levels of working
capital with investments in raw materials,
work-in-progress and finished goods
stocks, and with high levels of debtors.
The credit terms offered on sales and
taken on purchases will be influenced by
the normal contractual arrangements in
the industry.
Working capital
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Debtors
Volume of credit sales
Length of credit given
Effective credit control and cash collection
Stocks
Lead time & safety level
Variability of demand
Production cycle
No. of product lines
Volume of
– planned output
– actual output
– sales
Payables
Volume of purchases
Length of credit allowed
Length of credit taken – Discounts
Short-term finance
All the above
Other payments/receipts
Availability of credit Interest rates
Working capital
• Cash Levels
• it is necessary to prepare a cash budget where the
minimum balances needed from month to month will
be defined.
• business is seasonal, cash shortages may arise in
certain periods. Generally it is thought better to keep
only sufficient cash to satisfy short-term needs, and to
borrow if longer-term requirements occur
• The problem, of course, is to balance the cost of this
borrowing against any income that might be obtained
from investing the cash balances.
• The size of the cash balance that a company might need
depends on the availability of other sources of funds at
short notice, the credit standing of the company and the
control of debtors and creditors
Working capital
• Debtors
• The debtors problem again revolves around the
choice between profitability and liquidity. It might,
for instance, be possible to increase sales by
allowing customers more time to pay, but since
this policy would reduce the company’s liquid
resources it would not necessarily result in
higher Profits.
• historical analysis or the use of established
credit ratings to classify groups of customers in
terms of credit risk
Working capital
1.
2.
3.
4.
5.
6.
Establish clear credit practices as a matter of
company policy.
Make sure that these practices are clearly
understood by staff, suppliers and customers.
Be professional when accepting new accounts, and
especially larger ones.
Check out each customer thoroughly before you
offer credit. Use credit agencies, bank references,
industry sources etc.
Establish credit limits for each customer... and
stick to them.
Have the right mental attitude to the control of
credit and make sure that it gets the priority it
deserves.
Working capital
•
7. Continuously review these limits when you suspect
tough times
are coming or if operating in a volatile
sector.
8. Keep very close to your larger customers.
9. Invoice promptly and clearly.
10. Consider charging penalties on overdue accounts.
11. Consider accepting credit /debit cards as a
payment
option.
12. Monitor your debtor balances and ageing
schedules,
and don't let any debts get too large or
too old.
DIMENSIONS
OF
RECEIVABLES
MANAGEMENT
OPTIMUM LEVEL OF INVESTMENT IN TRADE RECEIVABLES
Profitability
Costs &
Profitability
Optimum Level
Liquidity
Stringent
Liberal
Working capital-FACTORING
• Factoring
Definition:
• Factoring is defined as ‘a continuing legal relationship
between a financial institution (the factor) and a business
concern (the client), selling goods or providing services
to trade customers (the customers) on open account
basis whereby the Factor purchases the client’s book
debts (accounts receivables) either with or without
recourse to the client and in relation thereto controls the
credit extended to customers and administers the sales
ledgers’.
Working capital-FACTORING
• It is the outright purchase of credit approved
accounts receivables with the factor assuming
bad debt losses.
• Factoring provides sales accounting service, use
of finance and protection against bad debts.
• Factoring is a process of invoice discounting by
which a capital market agency purchases all
trade debts and offers resources against them.
Working capital-FACTORING
Debt administration:
• The factor manages the sales ledger of
the client company. The client will be
saved of the administrative cost of book
keeping, invoicing, credit control and debt
collection. The factor uses his computer
system to render the sales ledger
administration services.
Working capital-FACTORING
• Different kinds of factoring services
• Credit Information: Factors provide
credit
intelligence to their client and supply periodic
information with various customer-wise analysis.
• Credit Protection: Some factors also insure
against bad debts and provide without recourse
financing.
• Invoice Discounting or Financing : Factors
advance 75% to 80% against the invoice of their
clients. The clients mark a copy of the invoice to
the factors as and when they raise the invoice
on their customers.
Working capital-FACTORING
• Services rendered by factor
• Factor evaluated creditworthiness of the customer (buyer
of goods)
• Factor fixes limits for the client (seller) which is an
aggregation of the limits fixed for each of the customer
(buyer).
• Client sells goods/services.
• Client assigns the debt in favour of the factor
• Client notifies on the invoice a direction to the customer
to pay the invoice value of the factor.
Working capital-FACTORING
• Client forwards invoice/copy to factor along with
receipted delivery challans.
• Factor provides credit to client to the extent of
80% of the invoice value and also notifies to the
customer
• Factor periodically follows with the customer
• When the customer pays the amount of the
invoice the balance of 20% of the invoice value
is passed to the client recovering necessary
interest and other charges.
• If the customer does not pay, the factor takes
recourse to the client.
Working capital-FACTORING
• Benefits of factoring
• The client will be relieved of the work relating to sales ledger
administration and debt collection
• The client can therefore concentrate more on planning production
and sales.
• The charges paid to a factor which will be marginally high at 1 to
1.5% than the bank charges will be more than compensated by
reductions in administrative expenditure.
• This will also improve the current ratio of the client and consequently
his credit rating.
• The subsidiaries of the various banks have been rendering the
factoring services.
• The factoring service is more comprehensive in nature than the
book debt or receivable financing by the bankers.
Working capital- INVENTORY
MANAGEMENT
• Managing inventory is a juggling act.
• Excessive stocks can place a heavy burden on
the cash resources of a business.
• Insufficient stocks can result in lost sales, delays
for customers etc.
• INVENTORIES INCLUDE
• RAW MATERIALS, WIP & FINISHED GOODS
FACTORS INFLUENCING INVENTORY
MANAGEMENT
Lead Time
 Cost of Holding Inventory
 Material Costs
 Ordering Costs
 Carrying Costs
 Cost of tying-up of Funds
 Cost of Under stocking
 Cost of Overstocking
Working capital
• Cost of Working capital
• The other aspect of the working capital problem
concerns obtaining short-term funds. Every source of
finance, including taking credit from suppliers, has a
cost; the point is to keep this cost to the minimum. The
cost involved in using trade credit might include forfeiting
the discount normally given for prompt payment, or loss
of goodwill through relying on this strategy to the point of
abuse. Some other sources of short-term funds are bank
credit, overdrafts and loans from other institutions. These
can be unsecured or secured, with charges made
against inventories, specific assets or general assets.
Working capital
• Disadvantages of Redundant or Excess Working Capital
õ Idle funds, non-profitable for business, poor ROI
õ Unnecessary purchasing & accumulation of inventories over
required level
õ Excessive debtors and defective credit policy, higher
incidence of B/D.
õ Overall inefficiency in the organization.
õ When there is excessive working capital, Credit worthiness
suffers
õ Due to low rate of return on investments, the market value of
shares may fall
Working capital
• Disadvantages or Dangers of Inadequate or Short Working
Capital
õ Can’t pay off its short-term liabilities in time.
õ Economies of scale are not possible.
õ Difficult for the firm to exploit favourable market situations
õ Day-to-day liquidity worsens
õ Improper utilization the fixed assets and ROA/ROI falls
sharply
Working capital cycle
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Example: X Company plans to attain a sales of Rs 5 crores. It has the following information for
production and selling activity. It is assumed that the activities are evenly spread through out the
year.
(a) Average time raw materials are kept in store prior to issue for production.2months
(b) Production cycle time or work-in-progress cycle time.
2months
(c) Average time finished stocks are kept in sale in unsold condition
1/2 months
(d) Average credit available from suppliers
1 1/2 months
(e) Average credit allowed to customer
1 1/2 months
(f)
Analysis of cost plus profit for above sales:
%
Rs. In Crores
Raw Materials
50
2.50
Direct Labour
20
1.00
Overheads
10
0.50
Profit
20
1.00
Total
100
5.00
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Working capital cycle
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Calculation of Working Capital Requirement:
1.
Total months to be financed to Raw Material
Time in raw material store
Working progress cycle
Finished goods store
Credit given to customer
Months
2
2
1/2
1 1/2
6
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2.
Less: Credit available from suppliers
1½
---------------Total months to be financed to Raw Materials
4½
---------------Total months to be financed to Labour
Production cycle
In Finished stock store
Credit to customer
2
½
1½
Total Months to be financed
4
Working capital cycle
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3.
Total months to be finacned to overhead
Production cycle
In finished goods stores
Credit to customer
2
½
1½
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4
1 ½
Less: Credit from suppliers
4.
------------Total months to be financed
Maximum working capital required
Raw Materials 4 ½ / 12 × 2.50
Direct Labour 4 / 12 × 1.00
Overheads
2½
× 0.50
2½
Rs in crores
0.94
0.33
0.10
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Maximum Working Capital
1.37
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END
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